How

How Securities
Securities Are
Are
Traded
Traded
Chapter 5
Jones, Investments:
Analysis and Management

1
 Brokerage
Brokerage
Operations
Operations
 Brokerage firms earn commissions on
executed trades, sales loads on
mutual funds, profits from securities
sold from inventory, underwriting
fees and administrative account fees
 Full-service brokers offer order
execution, information on markets
and firms, and investment advice
– Discount brokers offer order execution
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 Account
Account Types
Types
 Cash account: Investor pays 100% of
purchase price for securities
 Margin account: Investor borrows part
of the purchase price from the broker
 Asset management account:offers
checking and bank card service as well
as offering automatic reinvestment of
excess cash balances in money market
fund

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 Account
Account Types
Types
 Wrap account: Brokers match
investors with outside money
managers
– All costs, fees wrapped into one

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 Fees
Fees and
and Costs
Costs
 Brokerage commissions differ by
security, broker, and investor
– Institutional investors have greatest
negotiating power
– On-line trading offers significantly
lower commission rates to individual
investors
 Dividend reinvestment plans
permit reinvestment of dividends
in additional stock 5
 Orders
Orders in
in Auction
Auction
Markets
Markets
 Most NYSE volume from matched
public buy and sell orders
 Specialists act as both brokers
and dealers in the stocks
assigned to them
– Maintain the limit order book
– Keep a fair and orderly market by
providing liquidity
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 NYSE
NYSE Automation
Automation
 SuperDot: An electronic order
recording, reporting, routing, and
matching system
– Specialist’s Electronic Book records and
reports limit and market orders
– Preopening buy and sell orders matched
and imbalance reported to specialist
– Members send orders directly to
specialist for execution and
confirmation

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 Orders
Orders in
in OTC
OTC
Markets
Markets
 Dealers ready to either buy or sell
– Bid price is highest offer price to buy
– Ask price is lowest price willing to sell
» Ask price - Bid price >0 (dealer spread)
– “Makes a market” in the security
– More than one dealer for each security
in over-the-counter markets

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 Types
Types of
of Orders
Orders
 Market orders: Authorizes
immediate transaction at best
available price
 Limit orders: Specifies a particular
market price before a transaction is
authorized
 Stop orders: Specifies a particular
market price at which a market
order is authorized 9
 Settlement
Settlement
 Most settlement dates are three
business days after the trade date
– Legal ownership transferred and
financial arrangements settled with
brokerage firm
– Book-entry system reduces costs
 Transfer of securities and funds
between exchange members
facilitated by a clearinghouse
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 Regulation
Regulation
 The Securities Exchange Act (SEA)
of 1934 created the Securities and
Exchange Commission (SEC)
– Administers all securities law
– Monitors public securities transactions
» Requires issuer registration for public
offers
» Investigates indications of violations such
as “insider trading”
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 Regulation
Regulation
 Stock exchanges are also self-
regulated
– In own self-interest to regulate and
monitor member behavior
– NYSE “circuit-breakers” attempt to
reduce volatility
 NASD: Trade association that
regulates OTC brokers and dealers
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 Margin
Margin Accounts
Accounts
 To open margin account,
exchanges set minimum required
deposit of cash or securities
 Investor then pays part of
investment cost, borrows
remainder from broker
– Margin is percent of total value that
cannot be borrowed from broker
» Cash: 100% loan value; securities: 50% 13
 Margin
Margin Accounts
Accounts
 Federal Reserve sets the minimum
initial margin on securities
– Unchanged since 1974 at 50%
 Actual margin at any time cannot
go below the maintenance margin
level set by exchanges, brokers
– Investor’s equity changes with price
– Margin call when equity below
maintenance level
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 Short
Short Selling
Selling
 Investor borrows stock from broker
or held in “street name” accounts
 Borrowed security sold in open
market, to be repurchased later at an
expected price lower than sale price
– Investor liable for declared dividends
– Short sale proceeds held by broker
– Investor responsible for borrowed
shares
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